Scienter - knowledge of misrepresentation and intent to deceive OR reckless disregard for truth of statements to be relied on

Reliance by plaintiff

Intent to rely in misrepresentation

Damages caused by the reliance

Punitive damages are also available to the plaintiff

Liability to third party under common law

1. Negligence

- Privity Rule

- Restatement rule

- general Negligence

2. Fraud

Privity Rule

Most protective of accountants

Ultramares Rule

Accountant can only be liable to client(privity) and known primary beneficiaries (near privity)

Accountant must be aware that the use of the work is for a particular third party, and agree that the work will be used in a particular way.

About half the states adhere to this rule including MD

Restatement Rule

middle ground, modern rule

third party must be in the "intended class of users" in order to hold the accountant liable for negligence

focuses on the intended use of the work rather than the parties

about half the states- FL, Michigan, Ohio, Texas

general negligence

least protective

any third party who was a "reasonably foreseeable user" of the accountants work can hold the accountant liable for negligence

focuses on accountants serving as a public trust

only Mississippi currently uses this rule.

Liability to third party under common law
Fraud

Must prove MS RID

Rationale: accountants owe a duty to all third parties to prepare their reports without fraud, whether such reports are intended primarily for the benefit of third parties or not

Caveat: must be a casual relationship between the misrepresentation and the plaintiffs’ damages, which is often more difficult to prove for third parties

Securities act of 1933

Regulates initial public offerings of securities

requires a registration statement be filed with the SEC - which discloses all material facts regarding the offered securities, must include financial statements audited but an independent public accountant, must be made with due diligence

protects any person acquiring securities covered by the registration statement may sue the accountant

Securities act of 1933
What must the plaintiff show?

Must show: the audited financial statements contained a false statement or omission of a material fact

The burden of proof then shifts to the defendant and they must prove that she was not negligent, not fraudulent, and acted with due diligence

Due diligence

must prove that the accountant

-made a reasonable investigation

-had a reasonable basis for her belief

-and did infact believe that the financial statements that she audited and gave opinions on did fairly represent the financial condition of her client on the day for the time period involved

Securities Act of 1933
Possible defenses

Information was truthful as of the date the registration statement became effective

Omission was not material

Lack of causation - the plaintiffs loss was caused by something other than the misstatement or omission

Statute of Limitations

Securities Act of 1933
Statute of Limitations

Plaintiff must file a lawsuit within one year after the discovery, and no later than three years after the security is offered

Securities Act of 1933
Damages

Difference between the amount paid for the securities and:

- the value at the time of the Law suit

OR

- the value at the time of the disposal prior to the lawsuit

The recovery may not exceed the price at which the security was offered to the public

Securities Exchange Act of 1934

Requires and annual report

Prohibits fraudulent behavior in the secondary market

for accountants this usually means the financial statements issued with the annual report

Securities Exchange Act of 1934
Prohibits?

Prohibits Fraud

must prove MS RID

Any person who makes a statement that is false or misleading with respect to any material fact may be sued

Securities Exchange Act of 1934
Who does it protect?

Any buyer of seller of a security to which the false statement relates may sue the accountant, provided she:

- bought or sold at a price affected by the false statement

- relied upon the statement, and

- did not know of its falsity

Securities Exchange Act of 1934
Accountant Defense?

Good faith - lack of Scienter

No knowledge that the statement was false or misleading

No intent to deceive to gain an unfair advantage

Constructive Knowledge

a reckless disregard for the truth, turning a blind eye

This is not acting within good faith

"Controlling person"

both 1933 and 1934 have controlling person provisions, so supervisors, managers, and firms cannot escape liability

Criminal Liability

Both 1933 and 1934 contain criminal provisions and penalties

1933 - fine not more than 10,000 and imprisonment for not more than 5 years

1934 - fine not more than 5mil for an individual and/or imprisonment for not more than 20 years (fine not more than 25 mil for a firm)

Working Papers

Owned by the Accountant, but the company owns the information

Only have to turn over to the federal government, or an accounting board

save for 5 years

Privileged communications

Accountant may NOT refuse to testify regarding client communications

About a third of the states extend the privilege including MD, but DE does not.